Amid all of Wall Street's woes, one bit of significant economic news almost fell through the cracks this week: oil prices increased $16 on Monday, temporarily trading as high as $25 over the previous closing price. This is an all-time record high. Surely, it can't just be demand and supply that determined the price - not on a day when the Dow just happens to fall 370 points. Or can it?
Since 2002, you could take the last digit of the year, add a zero, and get roughly the price of oil for that year: $20 in 2002, $30 in 2003, and so on up to $70 in 2007. Then came 2008, when oil rose to record highs of $140 and above.
Much of that increase (if not all) was driven by simple economics. Led by the awesome rise of China's economy, many more people around the world suddenly started living - and consuming oil - like Americans. Demand went up, and supply hasn't been able to keep pace. Voilà, prices rise.
In May, when oil hit $120 per barrel, public outcry over high prices reached the halls of Congress. Always on the lookout for easy solutions, some lawmakers searched for culprits and mistakenly thought they had found them in oil speculators. The speculation theory would have made sense had we also seen rising oil stockpiles - traders hoarding oil in the hope of selling it for a higher price later. That wasn't the case.
Fortunately, legislation to curtail oil speculators never passed. Unfortunately, the uproar over high oil prices found another victim - the Lieberman-Warner cap-and-trade bill (remember that?) - due to the largely misplaced fear that climate legislation would drive up short-term oil prices even further.
Fast forward to last week. Oil prices fell from their mid-summer highs to as low as $91. That fall was also caused by basic economics. This time, it was the fear of a global economic slowdown caused, in part, by high oil prices. It's Economics 101: Demand projections went down while supply remained steady, so prices fell.
Then came this Monday. Fears of economic slowdown have been all around us, so demand projections, if anything, should point downward. Why would oil jump $25 before settling at a still-breathtaking increase of $16?
This time, one factor might indeed have been speculation - or rather the lack thereof. The broader market jitters caused some traders to close up shop. Fewer trades mean greater price swings. Technicalities in the way oil is traded were likely another factor. The clock ran out on contracts for oil to be delivered in October, which led to the typical end-of-month price spike. Others cited "stupidity" or "manipulation" as reasons. But, as always, fundamentals played a role. This time, it was the supply side that was affected by hurricanes Ike and Gustav.
The law of demand and supply is alive and well - phew, it's really the only law we've got. It also gives me a chance to plug the logical conclusion: The only real way to insulate our economy and pocketbooks from wide swings in the price of oil is to curb demand, ideally through a cap-and-trade system.
